Chapter 2 The Global Economic Environment

1. Chapter 2The Global Economic Environment

2. Remaining Questions from Last Week ?

3. My Expectations • That you will have read the relevant chapter in the textbook. • That you will have read the relevant Article/Case Study (even if you are not presenting) and that you actively contribute to the debate

4. Group Formation • Internationally, Ethnically, Sexually etc Mixed. Max 4 per group. No Singletons! • Group Name • Group Strap Line • Happy Birthday !

5. Top 10 Reasons For/Against the WTO

6. Introduction • This chapter includes • An overview of the world economy • A survey of economic system types • The stages of market development • The balance of payments

7. The World Economy—An Overview • In the early twentieth century economic integration was at 10%; today it is 50% • EU and NAFTA are very integrated • Global competitors have displaced or absorbed local ones

8. The World Economy—An Overview • The new realities • Capital movements have replaced trade as the driving force of the world economy • Production has become uncoupled from employment • The world economy, not individual countries, is the dominating factor

9. The World Economy—An Overview • The new realities, continued • 75-year struggle between capitalism and socialism has almost ended • E-commerce diminishes the importance of national barriers and forces companies to reevaluate business models

10. Economic Systems Resource Allocation Market Command Private Resource Ownership State Centrally planned capitalism Market capitalism Market socialism Centrally planned socialism

11. Market Capitalism • Individuals and firms allocate resources • Production resources are privately owned • Driven by consumers • Government’s role is to promote competition among firms and ensure consumer protection

12. Centrally Planned Socialism • Opposite of market capitalism • State holds broad powers to serve the public interest; decides what goods and services are produced and in what quantities • Consumers can spend on what is available • Government owns entire industries and controls distribution • Demand typically exceeds supply • Little reliance on product differentiation, advertising, pricing strategy

13. Centrally Planned Capitalism • Economic system in which command resource allocation is used extensively in an environment of private resource ownership • Examples • Sweden • Japan

14. Economic Freedom • Rankings of economic freedom among countries • free, mostly free, mostly unfree, repressed • Variables considered include such things as: • Trade policy • Taxation policy • Capital flows and foreign investment • Banking policy • Wage and price controls • Property rights • Black market

15. Free Hong Kong Singapore Ireland Luxembourg Iceland/U.K. Estonia Denmark Australia/New Zealand/United States Repressed Cuba Belarus Libya/Venezuela Zimbabwe Burma Iran North Korea Economic Freedom

16. Stages of Market Development • The World Bank has defined four categories of development using Gross National Income (GNI) as a base • BEMs, identified 10 years ago, were countries in Central Europe, Latin America, and Asia that were to have rapid economic growth • Today, the focus is on BRIC,Brazil, Russia, India, and China

17. Low-Income Countries • GNP per capita of $825 or less • Characteristics • Limited industrialization • High percentage of population involved in farming • High birth rates • Low literacy rates • Heavy reliance on foreign aid • Political instability and unrest • Concentrated in Sub-Saharan Africa • India is the only BRIC country

18. Lower-Middle-Income Countries • GNI per capita: $826 to $3,255 • Characteristics • Rapidly expanding consumer markets • Cheap labor • Mature, standardized, labor-intensive industries like textiles and toys • BRIC nations are China and Brazil

19. Upper-Middle-Income Countries • GNP per capita: $3,256 to $10,065 • Characteristics • Rapidly industrializing, less agricultural employment • Increasing urbanization • Rising wages • High literacy rates and advanced education • Lower wage costs than advanced countries • Also called newly industrializing economies (NIEs) • Examples: Malaysia, Chile, Venezuela, Hungary, Ecuador

20. Marketing Opportunities in LDCs • Characterized by a shortage of goods and services • Long-term opportunities must be nurtured in these countries • Look beyond per capita GNP • Consider the LDCs collectively rather than individually • Consider first mover advantage • Set realistic deadlines

21. Mistaken Assumptions About LDCs • The poor have no money. • The poor will not “waste” money on non-essential goods. • Entering developing markets is fruitless because goods there are too cheap to make a profit. • People in BOP (bottom of the pyramid) countries cannot use technology. • Global companies doing business in BOP countries will be seen as exploiting the poor.

22. High-Income Countries • GNI per capita: $10,066 or more • Also know as advanced, developed, industrialized, or postindustrial countries • Characteristics • Sustained economic growth through disciplined innovation • Service sector is more than 50% of GNI

23. High-Income Countries • Characteristics, continued • Importance of information processing and exchange • Ascendancy of knowledge over capital, intellectual over machine technology, scientists and professionals over engineers and semiskilled workers • Future oriented • Importance of interpersonal relationships

24. G-8, the Group of Eight • Goal of global economic stability and prosperity • United States • Japan • Germany • France • Britain • Canada • Italy • Russia (1998) 2007 G-8 leaders in Germany

25. OECD, the Organization for Economic Cooperation and Development • 30 nations • Post–World War II European origin • Canada, United States (1961), Japan (1964) • Promotes economic growth and social well-being • Focuses on world trade, global issues, labor market deregulation

26. The Triad • United States, Western Europe, and Japan • Represents 75% of world income • Expanded triad includes all of North America and the Pacific Rim and most of Eastern Europe • Global companies should be equally strong in each part

27. Product Saturation Levels • The percentage of potential buyers or households who own a product • India: 1% of people have telephones • Autos: 1 per 20,000 Chinese; 21 per 100 Poles; 49 per 100 EU citizens • Computers: 1 PC per 6,000 Chinese; 11 PCs per Poles; 34 PCs per EU citizen

28. Balance of Payments • Record of all economic transactions between the residents of a country and the rest of the world • Current account—record of all recurring trade in merchandise and services, and humanitarian aid • Trade deficit—negative current account • Trade surplus—positive current account • Capital account—record of all long-term direct investment, portfolio investment, and capital flows

29. Balance of Payments

30. In U.S. $ billions Germany 912 U.S. 819 China 593 Japan 566 France 449 Netherlands 358 Italy 349 Great Britain 347 Canada 317 Belgium 307 % of total EU 18.1 United States 12.3 China 8.9 Japan 8.5 Canada 4.8 South Korea 3.8 Mexico 2.8 Russia 2.8 Taiwan 2.7 Malaysia 1.9 Top Exporters in 2004

31. In U.S. $ billions United States 1,526 Germany 717 China 561 France 466 Great Britain 464 Japan 455 Italy 351 Netherlands 319 Belgium 286 Canada 280 % of total United States 21.8 EU 18.3 China 8.0 Japan 6.9 Canada 4.0 South Korea 3.2 Mexico 3.0 Taiwan 2.4 Switzerland 1.6 Australia 1.6 Top Importers in 2004

32. Overview of International Finance • Foreign exchange makes it possible to do business across the boundary of a national currency • Currency of various countries are traded for both immediate (spot) and future (forward) delivery • Currency risk adds turbulence to global commerce

33. Foreign Exchange Market Dynamics • Supply and demand interaction • Country sells more goods/services than it buys • There is a greater demand for the currency • The currency will appreciate in value Exchange risks and gains in foreign transactions

34. The Big Mac Index is based on the theory of purchasing-power parity (PPP), which says that exchange rates should move to make the price of a basket of goods the same in each country. The basket contains just a single item, a Big Mac hamburger, but one that is sold around the world. The exchange rate that leaves a Big Mac costing the same in dollars everywhere is our fair-value yardstick.

35. Purchasing Power Parity (PPP)The Big Mac Index • Is a certain currency over-/under-valued compared to another? • Assumption is that the Big Mac in any country should equal the price of the Big Mac in the United States after being converted to a dollar price

36. Managing Economic Exposure • Economic exposure refers to the impact of currency fluctuations on the present value of the company’s future cash flows • Two categories of economic exposure • Transaction exposure is from sales/purchases • Real operating exposure arises when currency fluctuations, together with price changes, alter a company’s future revenues and costs

37. Managing Economic Exposure • Numerous techniques and strategies have been developed to reduce exchange rate risk • Hedging involves balancing the risk of loss in one currency with a corresponding gain in another currency • Forward contracts set the price of the exchange rate at some point in the future to eliminate some risk

38. Looking Ahead to Chapter 3 • The global trade environment